Is 'Davos Man' Rethinking China?

The Jin Mao Tower, foreground, the Oriental Pearl Tower, center, and other buildings are seen from the Shanghai World Financial Center in Shanghai, China, on Monday, Feb. 26, 2018. Xi Jinping's decision to cast aside China's presidential term limits is stoking concern he also intends to shun international rules on trade and finance, even as he champions them on the world stage. Photographer: Qilai Shen/Bloomberg

What a difference a year makes!

Right around this time last year, Davos Man—the euphemism for the global elite that hobnob at the World Economic Forum in the Swiss Alps each winter—ironically held up the leader of China's Communist Party as their new main man.

Xi Jinping was the centerfold of the 2017 Forum's main issue. Their cover story: if the United States doesn't want to lead the world into a brighter, bigger globalized future, then the closed, one-party ruled economy of China most certainly will.

Their view is the complete opposite of everything they profess to stand for.

Last year, the World Economic Forum put China's Communist Party leader on full display: Xi Jinping, the hero of global trade. Photographer: Qilai Shen/Bloomberg

China spooked markets twice this week—first with the announcement that Xi would be made indefinite leader of the Communist Party. That was a nary a blip, though.

Thursday was the real shakedown. The Trump administration announced global tariffs on steel and aluminum made in China (and elsewhere, though China is the biggest producer in the world).

The market tumbled in its usual overreaction, closing down 420 points, which sounds worse than it really is. A 1.7% decline in the Dow on news that any China watcher worth a dime saw coming from a mile away should be considered relatively tame. Let's see how things close on Friday. The S&P 500 was down around half a percent in the pre-market hours, but Dow futures suggest another day deep in the red. The FTSE China (FXI) exchange traded fund was worse, down over 1.3% before the opening bell.

The point of making the tariffs global—for now—is so China can't ship steel to Mexico and get it into the U.S.

European leaders said they would fight the tariffs. The EU is the No. 2 producer after China.

The Commerce Department’s case for tariffs is likely being used as an example of an enforcement mechanism to get China to change its trade policies.

Here's the market take: the risk of a trade war with China is a new variable for the Fed to weigh. As such, this latest move will likely rein in hawkishness at the Federal Reserve. Treasury yields should head lower, as they did on Thursday, while equity investors weigh the risk. U.S. Steel Company shares rose over 5% on the news.

President Trump during a meeting with steel and aluminum executives in the White House on March 1, 2018. Trump said the U.S. will slap tariffs on steel and aluminum imports that could hit producers from Europe to Asia and spur global retaliation. China is the world's number one producer of steel and aluminum. Photographer: T.J. Kirkpatrick/ Bloomberg

Seriously Rethinking China

The foreign policy wonks and London economists are rethinking China. Xi Jinping is now so-last-year's poster boy for globalization fans.

Foreign Affairs magazine, hardly an anti-establishment voice, has an essay out in their March/April edition titled "The China Reckoning." Here is what it says:

Nearly half a century since (President Richard) Nixon’s first steps toward rapprochement, the record is increasingly clear that Washington once again put too much faith in its power to shape China’s trajectory. All sides of the policy debate erred: free traders and financiers who foresaw inevitable and increasing openness in China, integrationists who argued that Beijing’s ambitions would be tamed by greater interaction with the international community, and hawks who believed that China’s power would be abated by perpetual American primacy.

Neither carrots nor sticks have swayed China as predicted. Diplomatic and commercial engagement have not brought political and economic openness. Neither U.S. military power nor regional balancing has stopped Beijing from seeking to displace core components of the U.S.-led system. And the liberal international order has failed to lure or bind China as powerfully as expected. China has instead pursued its own course, belying a range of American expectations in the process.

Those bemoaning the decision to charge extra for those two Made in China metals are sticking up for a country whose prime goal is to protect its national economy and its labor market. This is the very thing they claim to disdain about the the new Disruptor-in-Chief in the White House. Free trade is good, fair trade is better. The bad guy: Washington. The good guy: Beijing.

Clearly not the guys who held up Xi Jinping as something akin to a war hero in the establishment's fight against Trump.

Perhaps this is just what "draining the swamp" looks like. There's bound to be a lot of muddy, messy, dead things flopping around at the bottom, depending on how much you drain out.

Either the U.S. will have to slap tariffs on China, or the U.S. will have to open its doors to get in more China investment to cut into that trade deficit with them.

But does China really want to invest in the U.S. on a larger scale than it is now? And does the U.S. even want China to invest here, considering the government has banned Chinese companies from doing so in the past, has had problems with Chinese stealing intellectual property at companies like Westinghouse Electric (now China's nuclear industry is bigger than Westinghouse and going its own way), and is actively warning people away from Huawei, a huge Chinese telecom company.

Writing in Foreign Affairs, Kurt Campbell, CEO of the Center for a New American Security, and Ely Ratner, a senior China fellow at the magazine's publisher, the Council on Foreign Relations (CFR), think Trump is on the right track, but has to tread carefully.

China does not have to be an American enemy. Indeed, they should not be. Markets definitely do not want a trade war and will react accordingly to the prospects of one.

"The Trump administration’s first National Security Strategy took a step in the right direction by interrogating past assumptions in U.S. strategy," they wrote, adding that Trump’s policy focus on bilateral trade, the abandonment of multilateral trade deals like the Trans Pacific Partnership, the questioning of the value of alliances, and less emphasis on diplomacy—have put Washington at risk of being too confrontational with Beijing, and not competitive enough.

Beijing, meanwhile, has managed to be increasingly competitive without being confrontational.

Some might argue that China has been able to be competitive because it is a relatively closed door economy. Google isn't in mainland China, so you get Baidu instead.

China is slowly opening the mainland up to foreign ownership of local firms. This is now happening in financial services, for instance. The U.S. doesn't want to close that door. Wall Street banks with hopes to help professionalize and develop China's A-shares market do not want to lose access to Chinese investors and domestic companies.

Investors still like China for its market size and its tech companies. But political risk of a deeper trade spat with the U.S. rose on Thursday, sending the U.S. stock market down over 400 points. (AP Photo/Mark Schiefelbein, File)

No one is going to change China by bullying them, nor are they going to get their wishes by pretending China is the new leader of the free world like they did at the World Economic Forum last year.

"Washington should...base policy on a more realistic set of assumptions about China (that) would better advance U.S. interests and put the bilateral relationship on a more sustainable footing," the Foreign Affairs essay states. "Getting there will take work, but the first step is relatively straightforward: acknowledging just how much our policy has fallen short of our aspirations," the authors wrote.

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I've spent 20 years as a reporter for the best in the business, including as a Brazil-based staffer for WSJ. Since 2011, I focus on business and investing in the big emerging markets exclusively for Forbes.